George Weston Foods, Australia’s second-largest baker, is lifting bread prices by about 5.6 per cent after convincing major retailers it can no longer absorb higher costs for wheat, energy and labour.

George Weston chief executive Andrew Reeves said more price rises, as well as cost cutting and new product development, would be necessary over the next few years to restore profits and returns, which have been declining since 2008.

In an exclusive interview with the Weekend Financial Review, Mr Reeves revealed the 70-year-old company is no longer achieving its cost of capital because of poor returns from two key businesses, fresh baked bread and smallgoods.

George Weston accounts for about 31 per cent of the loaf bread market, competing with market leader Goodman Fielder, but the growth of cheap private label bread, which now accounts for 16 per cent of the market, and spikes in soft commodity costs have decimated margins at the major bakers.

“Our return on capital employed in our Australian baking business is well below our cost of capital at the moment, so that’s not a sustainable position," Mr Reeves said.

The group, 100 per cent owned by Associated British Foods of the UK, reported an operating loss on sales of $2 billion in the 12 months ended September after booking restructuring costs of $35 million.

“It’s not a lack of efficiency or cost management because inside those baking houses we’ve been really rigorous – there have been plants closed and investment in automation – we’ve been working very hard," he said.

“The biggest challenge is the price generally; we haven’t been securing consistent or regular price increases in bread and the growth in private label and most recently the very aggressive promotion of private label by the major customers has clearly had an impact. In the last 12 months, category volume has barely changed but the value is down by 6 per cent or 7 per cent.

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George Weston’s problems mirror those at
Goodman Fielder
, where chief executive Chris Delaney is aiming to reduce costs by $100 million by 2015 and re-engineer the supply chain to boost bread earnings, which have fallen 38 per cent over the past four years.

Goodman has been investigating options such as delivering bread to retailers’ distribution centres rather than stores and extending the shelf life of bread to reduce distribution costs, which are equivalent to the cost of production.

However, Mr Reeves said George Weston was reluctant to move away from a model where fresh bread was delivered to stores daily.

“We think that provides the best possible consumer experience," he said. “We’d like to try and persist with the daily fresh model and see if we can deliver good sustainable returns out of that longer term."

Mr Reeves has taken the knife to George Weston’s cost base, reducing annualised costs by $60 million over the past 12 months by cutting 380 mainly management jobs, reducing the number of business units from seven to four (baking, Don KR smallgoods, milling and Jasol, a hygiene services business).

It is also overhauling a system whereby some 800 independent contractors deliver and merchandise 1 million baked products to more than 18,000 customers every day.

Some contracts have been terminated and others renegotiated, triggering industrial action at GWF’s Tip Top Bakeries by drivers who say they have been asked to deliver more bread for less income.

“Some of the distributors are unhappy with some of new arrangements and we are working through that," Mr Reeves said.

“For the business to be sustainable we’ve got to make these sorts of changes so we can continue operating."

Cost savings and price rises aren’t the only answer.

As the quality of private label bread improves, George Weston and its rival are under increasing pressure to innovate and create new products to grow top-line sales.

Tip Top’s “The One" has won 10 per cent of the white sliced segment since it was launched earlier this year and Mr Reeves is keen to add more “international" styles, flat breads and wraps to the range.

“We could do it ourselves, partner with people, do third-party manufacturing or through acquisition," Mr Reeves said.